Private Markets Are No Longer the Wild West

Barrett Cohn

December 19, 2016

Nothing captures the imagination quite like the Wild West. It was a place of adventure, lawlessness and rugged individualism. People could stake their claims and even build an empire through sheer force of smarts and will.

The Wild West was also known for smallpox, rattlesnake bites, inadequate protein sources, choking dust, stray bullets (silver and otherwise) and outdoor plumbing. You don’t hear quite as much about those parts…

Empires are being built again in the West. Silicon Valley (and, to a lesser extent, technology hubs in Austin, Seattle and Los Angeles) feel to many like the new Gold Rush country, attracting significant investment. But unlike prospectors with nothing to lose, when people think about making a sizable investment in a technology company, they want to know the totality of risk before deciding for or against. Rational people should not bet heavily on something that simply “sounds great.”

This said, some of the most exciting investing going on today — in valuable, privately held technology companies — is occurring in a Wild West environment. It’s exciting, sure, but also, at least where individual investors are concerned, tends to be characterized by imbalances of information, opacity and risk.

The impulse to invest is understandable. People want to make early bets on the next Google, Facebook or Uber, just like leading VCs and mutual funds do. And many people turn to offline and online marketplaces where “shares” in such companies can be bought (in reality, many of these marketplaces sell mere synthetic interests in companies, not actual direct ownership in the company itself). Tech company employees have found a venue to sell shares in these marketplaces, as many want some liquidity as they await an IPO that could be years away — if it ever comes at all.

Deals done through these marketplaces are often done with no information about the buyers and the sellers, and scant if any data regarding the overall health of the company. And with such a paucity of information, it’s difficult for any buyer to know whether the “shares” are being priced fairly. And more importantly, hard for any new stakeholder to see where the risks might lie​​.

But there’s good news for valuable companies, their management and founders, and the employees who fuel their growth (this story had to get better, didn’t it?). The private markets are starting to look a lot less like the Wild West. Over the last handful of years, even as companies have responded to the Wild West atmosphere that characterized the frequent, small, and information-free trades in private companies like pre-IPO Facebook by restricting their shareholders’ ability to sell stock, a new version of potential liquidity has begun to emerge. It has become possible in this environment for founders, management, employees and early investors to sell their private company shares in a company-approved process with information judiciously shared and new investors attracted.

In fact, some of the most progressive late-stage technology private companies, even as they stay private longer and watch their valuations grow significantly, are addressing the pent-up demand for liquidity among their staff and early investors by supporting controlled liquidity programs. This generally involves supporting a market process whereby stakeholders are allowed to sell a portion of their highly appreciated stock to a deep-pocketed institutional investor who wants to support the company’s long-term development, rather than simply reap a quick return.

Having completed many dozens of these transactions, we have already seen the power of an orderly secondary market where transactions done with the full approval and participation of the subject company can benefit all parties involved: the seller(s); the company; and the new strategic investor(s). Not only should deals be done this way, it’s going to become another new normal.

Late-stage private-company shares are an exciting, new asset class: the domain of long-term institutional investors able to assess and take risk. But the process for buying and selling shares should be neither adventurous, nor full of unseen risks. Fortunately, the Wild West days for the private markets are ending.